“Russia sanctions point to binary outcome” says Deutsche’s Wöhrmann
The recent civilian airplane incident in East-Ukraine, which is still not officially resolved, indeed has taken the dispute between the West and Russia to another level. As a result of this incident, the West is imposing new sanctions on Russia.
Taking a new level: While former sanctions were mainly focused on individuals or companies, these measures rather have an economic dimension. Both the EU and the U.S. extended their sanctions list, now including (among others): a ban on long-term financing (maturity >90 days) for Russian state-owned banks and a ban on future exports of specified oil-exploration and oil-production equipment to Russia.
Hopes for political solution: However, these sanctions leave the door open for a solution based of negotiations. The review after 90 days and making the ban only valid for 12 months reveal the underlying hopes for a potential solution without imposing ever-stricter sanctions.
Eurozone (EUZ) – Direct effects mainly through trade channel: Overall direct effects from trade sanctions on EUZ economy in the range of 0.1-0.4 percentage points of GDP possible for 2014/2015*, though compensating effects from other growing regions have to be taken into account. Overall negative effects dependent on how much domestic economic sentiment will be hurt by sanctions and also through Russian reaction. So far EUZ growth has been supported by domestic demand.
Russia – Growth experiences further hit: Growth forecast are already low/negative. Further deterioration possible due to potentially more expensive/more difficult financing for banks and corporates. Thus, loan growth is also likely to be slower.
Potential consequences for equity and fixed income markets
First reaction positive: Initially, the Russian market reacted positively, apparently reflecting its participants’ expectations for more severe sanctions.
Banking sector with little direct effects: Measures have a direct impact on the banking sector by restricting Russian banks’ financing in euro and dollar. However, Russian’s central bank declared to support those banks subject to the sanction package, thereby is easing the immediate impact and stabilizing the sector. European banking sector with high exposure, allocated among a few banks, overall there is no immediate need for concern.
Energy sector exemption (mostly): While Russia’s core business, conventional oil production, is not subject to bans, non-conventional oil is. And as a matter of fact, Russia is not producing non-conventional oil, nor has it significant exposure to the equally affected energy-equipment sector.
Trading might decrease: Trading might experience lower volumes due to short-term borrowing being affected. Total impact not yet quantifiable, though.
Access to the markets: While corporates have restricted access to markets, the sovereign state is not subject to the sanctions decided upon. We do not expect the negative growth implications to feed through on the financing conditions due to the already low growth expectations. Yet, both the sanctions’ potential persistence after the review, which takes place after three months, and Russia’s reaction might have further implications and have to be kept in mind.
Rating hanging in the balance: Although Russia is a net creditor to the world and holds high exchange reserves, its rating might be lowered going forward. All rating-agencies’ outlooks are already negative and a further deterioration of the situation might tip the scale towards downgrading Russia to a sub-investment rating.
Headline-driven corporates market: Credit risk for Russian corporates will continue to be driven by sanctions or retaliation related headlines. Sanctioned credit vs. non-sanctioned credit definitely show a different degree of reaction but so far price action is not reflecting company fundamentals (e.g. country’s weaker economic backdrop, high vs. low degree of reliance to external financing). If sanctions prevail after review, Russian corporate bond price reaction might increasingly reflect on liquidity, refinancing and credit metrics. Offsetting forces to this current negative scenario could be: Russian government’s explicit commitment to support Russian companies in terms of banking-system capitalization and in terms of maintaining high access to funding for the corporate. It will be important to watch closely those corporate, in which individuals who appear on sanctions lists hold an ownership stake.
Portfolio outflows accelerating: Outflows of portfolio investment might increase further. Thus, reserves might be used to stabilize the ruble. If Russia should run short of money, the central bank might rather sell its bonds than touching its gold reserves. Due to the short maturity of these bonds (emerging markets’ central banks normally hold short-maturity bonds only), severe impacts for the international bond markets are not very likely.
The EU and the U.S. take a step towards level-three sanctions and mark a turning point in the dispute. The future now points to a binary outcome: escalation or de-escalation. Impact on Russian‘s economy and markets limited in the short-term. This is due to Russia’s intact ability to finance itself and its core energy sector being exempt. But, the sanctions‘ time horizon and Russia‘s reaction function as decisive. We will watch the situation closely for risks to the downside and chances for the upside.